Section 16(2)(c) of the CGST Act- Why Vendor Compliance Has Become Crucial for Claiming ITC

Input Tax Credit (ITC) is one of the biggest benefits available under GST. However, many businesses assume that once they receive a GST invoice and make payment to the supplier, they can safely claim ITC. Unfortunately, that is not always true.

Section 16(2)(c) of the CGST Act has made vendor compliance extremely important. This provision states that a buyer can claim ITC only if the supplier has actually paid the GST to the Government.

In simple words, your ITC depends not only on your compliance but also on your vendor's compliance.

A Practical Example

Suppose ABC Pvt. Ltd. purchases office furniture from XYZ Traders.

• Value of furniture: ₹1,00,000
• GST @18%: ₹18,000
• Total invoice amount: ₹1,18,000

ABC pays the entire invoice amount of ₹1,18,000 to XYZ Traders and claims ITC of ₹18,000 in its GST return.

Later, during a GST assessment, it is found that XYZ Traders filed GSTR-1 but failed to pay the GST liability through GSTR-3B. Since the tax was never deposited with the Government, the ITC claimed by ABC may be denied under Section 16(2)(c).

As a result, ABC may have to:

• Reverse the ITC of ₹18,000.
• Pay interest on the reversed ITC.
• Face unnecessary litigation and compliance costs.

This means that even though the buyer has paid the supplier in full, the ITC can still be disputed if the supplier defaults in paying GST.

Why This Provision Matters

Many businesses deal with hundreds of vendors. If even a few of them fail to comply with GST requirements, the buyer's working capital can be significantly impacted.

For example, a company claiming monthly ITC of ₹50 lakhs from over 200 vendors may receive a tax demand if certain vendors fail to discharge their GST liability. Recovering such amounts from vendors after several years can be difficult.

Therefore, ITC is no longer just an accounting exercise—it has become a vendor risk management exercise.

Additional Steps Every Business Should Take for All Vendors

To safeguard ITC, businesses should implement a structured vendor compliance process.

1. Verify GST Registration

Before making any purchase, verify the vendor's GSTIN on the GST portal and ensure that the registration is active.

2. Match Invoices with GSTR-2B

Every month, reconcile purchase invoices with GSTR-2B.

Ensure that:

• The invoice is reflected in GSTR-2B.
• The GST amount matches.
• The supplier has uploaded the invoice correctly.

Invoices not appearing in GSTR-2B should be immediately followed up with the vendor.

3. Track Vendor Return Filing Status

Regularly monitor whether vendors are filing:

• GSTR-1
• GSTR-3B

A vendor who frequently delays filing GSTR-3B may become a high-risk vendor from an ITC perspective.

4. Obtain Vendor Compliance Declarations

For major vendors, obtain a periodic declaration confirming that:

• GST has been deposited with the Government.
• GST returns have been filed.
• There are no significant GST defaults.

This creates an additional compliance trail.

5. Classify Vendors Based on Risk

Businesses should classify vendors into:

Low Risk

• Regular return filing
• Invoices reflected in GSTR-2B
• Good compliance history

Medium Risk

• Occasional filing delays
• Minor invoice mismatches

High Risk

• Frequent non-filing
• Invoice mismatches
• GST registration issues
• Repeated compliance defaults

High-risk vendors should be monitored closely before releasing payments.

6. Link Payment Approval with GST Compliance

For important vendors, payment approval should include a GST compliance check.

For example:

• Invoice received ✔
• Goods or services received ✔
• Invoice reflected in GSTR-2B ✔
• Vendor has filed GSTR-3B ✔

Only after these checks should payment be approved, wherever commercially feasible.

7. Perform Quarterly Vendor Reconciliation

Conduct a quarterly review of:

• GSTR-2B reconciliation
• Vendor filing status
• ITC mismatches
• Reversed credits
• Outstanding vendor confirmations

This helps identify compliance issues well before a GST notice is received.

8. Obtain a Year-End CA Certificate and Vendor Indemnity

At the end of every financial year, businesses generally collect MSME declarations or certificates from their vendors. Along with these documents, it is advisable to obtain a certificate from the vendor's Chartered Accountant confirming that the GST relating to the invoices raised on your business during the financial year has been duly paid to the Government.

Further, businesses may obtain an undertaking or indemnity from the vendor stating that if the GST department subsequently reverses the ITC under Section 16(2)(c) due to the vendor's failure to deposit GST, the vendor shall reimburse the recipient for the amount of ITC reversed along with any applicable interest and penalty.

Although this certificate or undertaking does not override the provisions of the CGST Act or prevent the department from initiating action, it provides a strong contractual safeguard and strengthens the recipient's position while recovering losses from a defaulting vendor.

9. Review the "% Liability Paid" of Your Vendors

The GST portal provides a useful compliance indicator that many businesses overlook.

After logging in to your GST account, use the Search Taxpayer option and search the vendor's GSTIN. On the taxpayer's profile, review the "% Liability Paid" details available on the portal.

If the vendor has consistently paid 100% of their GST liability, it indicates a healthy compliance track record. However, if the percentage is consistently low or fluctuates significantly, it may indicate that the vendor is not regularly discharging their GST liability.

While this is not conclusive proof of compliance, it is an excellent due diligence tool for identifying high-risk vendors.

Practical Tip: Review the "% Liability Paid" of all key vendors at least once every six months and maintain screenshots or records as part of your vendor compliance documentation.

A Practical Vendor Control Process

A simple internal process can significantly reduce ITC risk:

1. Receive the invoice.
2. Verify the vendor's GST registration.
3. Record the purchase.
4. Match the invoice with GSTR-2B.
5. Follow up for missing invoices.
6. Check the vendor's GST filing status.
7. Review the vendor's "% Liability Paid" on the GST portal.
8. Approve payment after completing compliance checks.
9. Conduct quarterly vendor reconciliation.
10. Obtain the annual CA certificate and vendor undertaking.

Final Thoughts

Section 16(2)(c) has fundamentally changed the way businesses should manage their vendors under GST. Today, claiming ITC is not merely about possessing a valid tax invoice or making payment to the supplier. It also requires confidence that the supplier has discharged the corresponding GST liability.

A proactive vendor compliance framework—supported by regular reconciliations, GST portal checks, vendor declarations, annual CA certificates, and contractual undertakings—can significantly reduce the risk of ITC reversals, interest liability, and prolonged litigation.

In today's GST environment, vendor due diligence is no longer optional—it is an essential part of every business's tax compliance strategy. GST Return Filing